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Harry's bike. How can we factor in non-market valuations into real estate?

In 2010 I bought a Brompton SL3 for £900 and have since invested in maintenance - a new back wheel, brake pads, replacement chain’s, new tyres, a lock, a bag, some clothing and insurance. I estimate my total expenditure at around £2,500 over the seven year period. These costs have an offset however - I have mostly avoided using any form of public transport, which would have cost me around £7,500 over the same time period. Therefore the net benefit to me of purchasing my Brompton all those years ago is around £5,000. On this calculation my Brompton purchase has been a worthwhile investment.

 

But these figures don't tell the whole story - I have had some of the best times riding through the streets early in the morning. I have also enjoyed the massive personal benefit of not having to negotiate an overcrowded mass transit systems at rush-hour.  So what about these benefits - can we include these?

The answer is yes, and there are a number of techniques to account for intangibles, which having found success in a public policy setting, are gaining traction in a business context.  They are especially important, and useful, when making decisions that have a social or environmental impact where benefits and costs may not be fully reflected by market prices.  A good current day example is air quality, there is no market price for good air quality, but its value can be seen indirectly, for example through changes in house prices (down by as much as 15% - see here).

In the bike example I have two broad options available to quantify intangible benefit - stated preference or revealed preference.  I've chosen stated preference for simplicity and speed.  This is an umbrella term for methods based on the assumption that people's intended behaviour in hypothetical markets reflect preferences for non-market goods. Arguably revealed preference can provide more ‘real’ result as they are based on actual market transactions such as in the air quality/ house price example above. However, it can be difficult to isolate factors – the house may be in an area of poor air quality and next to a noisy motorway for example – and so the context of the assessment is important.  

Generally, within a stated preference methodology, people are asked what they are willing to pay, or willing to accept to be compensated for changes in their environmental quality.  I think I would be willing to pay £5 per month to avoid using the tube in my daily commute (how does this sound to you - high, about right, too low?).  Should I include this, making appropriate adjustments for time, the net benefit increases by around £2,000 to £7,000. Thereby making a clear argument for cycling to work in my case.  It also shows that the purchase of the bike (but not all the maintenance) is validated on intangible benefit alone.

While simple, and by no means comprehensive, this example shows the potential for non-market valuation techniques to inform decision making. It can also highlight the complexities - I have included the intangible upside but not the downside; for example there is no risk of injury, aversion to physical exercise, or even fear of being sweaty values within the calculations. 

Potential in the real estate sector

There is significant potential within the real estate sector to couple these techniques with developer’s residual appraisals – a tool used for assessing the value of a potential site or redevelopment scheme.  Like a cost-benefit analysis (or more accurately a benefit-cost analysis) undertaking a residual appraisal involves establishing the cash benefits of the proposed scheme (i.e. Gross Development Value), then netting off the costs (including an assumed amount of profit), to be left with a (residual) amount for the land purchase. 

In order to use an integrated approach of both techniques, a developer could undertake a stated preference assessment at the community engagement stage by asking how much the public would be willing to pay for the new scheme, or willing to accept to forgo the current status quo. A lot depends on the context - if the proposal is to redevelop a disused car park the chances are a willingness to pay calculation would be most suitable, whereas if the scheme is a greenfield redevelopment where amenity space is lost, then a willing to accept to forgo calculation would be more appropriate.  These additional social or environmental benefits could then be used to show wider value and allow a deeper conversation with local authorities during the planning process. Drawing a boundary on who should be included in the engagement process is an important, but not easy, question to answer. A larger survey would yield more robust results but could also lead to viability issues. Ultimately, it would be a decision based on the type and size of scheme.

Opportunities

For me the opportunities are obvious - the cost benefit analysis is something we all understand, it is a quantitative assessment which delivers a single figure. If positive and sufficiently large - then generally the idea is supported, if negative or small then it becomes questionable. However social and environmental values are less well understood.  As such, adding these elements into an assessment will help guide our decision making in a way that isn't captured at present. It also has the benefit of evolving a well-established approach that is commonly used across many sectors, rather than starting afresh. 

These approaches are especially important at a time when housing is in chronic shortage. In relation to those sites that fail to stack financially or are marginal, I’d be interested to see if an argument could be made for reducing section 106 costs, or increasing the density of a scheme, provided additional communal space, sports facilities, or areas of high ecological value be included with support from a comprehensive cost-benefit analysis accounting for these social and environmental factors. Conversely, the approach should work both ways and provide an argument for greater S106 contributions if social or environmental costs are found to outweigh the benefits. The approach could also be coupled with other environmental assessments such as the Biodiversity Net Gain Framework WSP developed, which ensures new development enhance, rather than degrade, nature. 

Harry Knibb is WSP principal consultant for the Sustainable Places, Energy and Waste team.